Royal Mail faces threat of VAT charges on business contracts

Royal Mail is facing another serious threat to its efforts to compete with private-sector rivals, just weeks after trades unions agreed to call a halt to a debilitating series of strikes during negotiations with the company.

The postal operator has been told by HM Revenue & Customs (HMRC) that it will soon be forced to begin charging valued added tax (VAT) for many of its services, having previously been exempt. At a stroke, that would add 17.5 per cent to the prices it charges businesses, rendering it at a serious competitive disadvantage.

HMRC's ruling follows a judgment in the European Court of Justice (ECJ) in a case brought by TNT Post, one of Royal Mail's fiercest competitors in the UK. Under European Union law, publicly owned postal operators are exempt from having to charge VAT on their services and Royal Mail has always been able to enjoy this protection.

However, last month, TNT successfully challenged Royal Mail's exemption, on the grounds that it should not apply on commercial contracts subject to a competitive tendering process. The ECJ ruling means that in most cases where Royal Mail pitches for work with business customers – the most crucial part of its market – it will now have to begin charging VAT, as all of its private-sector rivals already do.

HMRC has given the organisation a period of grace during which discussions will take place over exactly which contracts and services will be affected, but the change is expected to take effect early in the new year.

Alan Pearce, a partner at the accountancy Blick Rothenberg, warned that the ruling could make it even tougher for Royal Mail to fight off the competitive threat posed by operators such as TNT, which are already attempting to capitalise on poor industrial relations at the Royal Mail.

"Some of Royal Mail's customers won't be affected because they're VAT-registered too and thus able to reclaim the tax," Mr Pearce said. "But for many potential clients in sectors where that is not the case, this could be a real threat to Royal Mail's ability to continue winning their business."

Mr Pearce also warned that the ECJ ruling might encourage the European Commission to speed up work it is already carrying out on whether public postal services should continue to be exempt from VAT in any circumstances at all. "This could be the spark that leads to a change in EU law to withdraw the VAT exemption for all public postal services, which would be even more serious for Royal Mail," Mr Pearce added.

Royal Mail already faces opposition to its VAT exemption within the UK, with bodies such as the Adam Smith Institute, the free-market think tank, calling for its abolition.

"The Post Office is uniquely exempt from paying VAT on its services, as its would-be competitors have to," Madsen Pirie, the president of the Adam Smith Institute, said last month. "This means that a rival has to be 15 per cent more efficient to compete effectively – most markets are won or lost on much smaller percentage margins than that."

In theory, Royal Mail could be forced to introduce VAT charges from January, when the tax rate returns to 17.5 per cent from the 15 per cent concessionary rate introduced by Alistair Darling, the Chancellor of the Exchequer, on a temporary basis a year ago as the UK slipped into recession.

The introduction of the charge might also coincide with further bad publicity for Royal Mail over its dispute with the Communication Workers Union. The union agreed to call off its programme of strikes earlier this month in order to give it more time to come to an agreement with Royal Mail over modernisation plans, but negotiations are continuing and could yet break down again. The TUC has said there will be no more strikes before Christmas, but action is still possible in the new year.

A spokesman for Royal Mail said the organisation could not comment on the VAT issue because "discussions with HMRC were continuing".